Constructive criticism and found delights

The goings-on onvariouseconoblogs regarding Rattner supposedly threatening the creditors who didn't go along with the Chrysler debt cramdown is one of the more generally well-written "you people are missing the pot" things I've read in a long while.

Chrysler, of course, filed for a Chapter 11 bankruptcy reorganization after all the creditors could not come to an agreement. The Obama administration, by way of the Treasury Department and Steve Rattner (the "car czar"), managed to get the four largest lenders (who had no choice, as they're being propped up by TARP funds), the UAW, and Fiat on board. But the agreement failed to get enough support from all stakeholders, and President Obama all but blamed the non-TARP debtholders for the bankruptcy filing during a news conference the morning of Thursday, April 30. Of course, the non-TARP guys objected to this characterization. Later in the late afternoon April 30, Perella Weinberg, one of the leaders of the non-TARP group, came around and supported the administration's plan, but it was too late. The bankruptcy was set. A lawyer representing the non-TARP lenders said that Perella Weinberg only came around because of threats made by the administration to bring negative PR to bear by way of their supposed influence over the White House press corps. Perella Weinberg, of course, denied this.

On Finem Respice, Equ Privat wrote that there was a more sinister threat - that the administration did not just threaten bad PR, but would bring the IRS and SEC to bear upon the non-TARP creditors, their employees, families, alma maters, dogs, and favorite sports teams. Of course, this could be seen as an abuse of power (as we are all terrified of the IRS and all investment managers are scared of the SEC's ability to "slow them down"). Equ Privat called the purported Rattner threats "fascist". For this, she was mocked, mercilessly. The author of The Epicurean Dealmaker, used Looney Tunes to jab at the non-TARP creditors, saying "[i]t's called politics, you fucking morons. Stop being such a bunch of whiny pansies." The point TED made was that even if such a PR threat was made, there were a lot of people in the government under under a lot of stress, and the threat was just a negotiating tactic anyway.

As Felix Salmon points out, the non-TARP creditors don't have much of a leg to stand on for their whining, coerced or not into a supplicant position at the mercy of the bankruptcy judge. Their position in Chrysler was a moral hazard one - "of course the Obama administration won't let Chrysler go bankrupt". Thus, if it won't go bankrupt, as senior secured creditors, they stood the most to gain. Pretty simple arithmetic. Problem was that they didn't think the administration would really let Chrysler go bankrupt - albeit a Chapter 11 reorg rather than a Chapter 7 liquidation - and they did, because they had all the post-event actors on their side: Chrysler management, the large banks, and a private actor, Fiat, to act as a savior.

This was a completely predicatable outcome, and the non-TARP guys treated it as impossible. They assumed that the sanctity of American bankruptcy law and precedent would strengthen their hands well enough to force a positive outcome for their vulture investment. The non-TARP creditors are morons, not for whining, but for not seeing this play out the way that it did.

It's called political risk.

Look, we generally think of political risk when making investments in, say, Pakistan or Russia. But to completely discount the political risk of a vulture investment in Chrysler debt is completely insane. The notion that a Democratic administration was going to stand idly by as vulture investors were going to cram down the UAW and TARP banks is foolish. One, there's a legitimate policy argument that the United States needs a Detroit-based domestic automobile manufacturing enterprise for national security. You can agree or disagree, but it's a legitimate policy position. Two, the UAW is a powerful union in a swing state. To put it another way, the UAW ain't UNITE HERE. Three, it was completely forseeable that the Obama administration would take advantage of the troubles at GM and Chrysler to kickstart their environmental policy goals.

The idea that the administration would put all of that aside based on fealty to the well-established order of creditors that you'd have in any traditional bankruptcy, as the non-TARP creditors believed, is naive at best and a violation of the prudent man standard at worst.

Look, in most vulture situations, the non-TARP creditors would be right. You'd have an orderly liquidation, and the secured creditors would be in the front of the line to receive proceeds. But not here - the political risk wasn't even close to zero. It'd be like making a bunch of greentech investments with Dick Cheney and Phil Gramm as President and Vice President. You have to, at the very least, merely consider that maybe, just maybe, future policy decisions will make your current investment thesis weaker.

The non-TARP creditors were insane to think their hand was as strong as they played it. It wasn't even a bluff - they really thought they were playing Omaha high low and that they were holding a Wheel. In the end, it turned out they were playing 52 card pickup and they lost.